Oh, SNAP

We can only hope that they can avoid the hair-pulling and face-scratching. If we can just keep them gossiping and sniping and at separate tables in the high school cafeteria instead of getting physical....

Fortunately there are adults tackling the pressing issues of the day ... oh, wait.... Well, perhaps another day President Obama can set the tone for a "productive and serious conversation going forward." Today he failed abysmally.

Pending Home Sales January

In the post below I took a skeptical look at the January Personal Income and Outlays report. The press seems a touch confused about what it's really saying.

Now on to Pending Home Sales. What was previously reported as an increase in December has been revised to a decline, and January's pendings dropped again. YoY -1.5%; the west and south are doing better with only small YoY declines, whereas the northeast and midwest fell at 3% and 3.2% YoY. It should be interesting to watch WS economists try to put lipstick on this pig. Oh,but maybe they aren't going to play that game. Read the Bloomberg article and the projected impacts on housing values.

I guess the takeaway is that the Fed is going to be considering QE3 or something to that effect. CR is absolutely right about the strong marginal effect that home-building has on the US economy.

Chicago PMI jacked up again. It's a really strong report. But now integrate consumption trends and home-buying trends, and the cautionary motto appears. ISM and PMI reports really can't get much better than we have now, and if you don't believe me, read the full report at the link. These figures are close to the 40 year maximums and way above the medians. Except for employment, which dropped hard to 59.8, still well above the 40 year median of 50.1. Last month it was very close to the 40 year maximum (64.1 to a 40 year max of 67.4). Comments this month are mostly focused on price increases.

What is different about the current recovery compared to the end of the early 1980s downturn and 84 rebound are the previous bubble and its hangover effects on consumer incomes, debt loads, and ability to take on new debt. Plus demographics, of course. These are intractables that must be lived down and through. Blaming Obama for a lot of this is inane; no US administration can change what happened before or the ages of the population. But it is true that high-speed rail and windmills, and cutting taxes on those with incomes significantly above the median while raising taxes on those with below median incomes won't help and will do damage.

I feel sorry for our politicians; they are governing in an environment in which beneficial policies are hard to develop and give relatively little return.

PS: One thing I forgot to mention reqarding western pendings: Since November there has been an epic drop on a seasonally-adjusted basis. November 2010 was 117.8 and January came in at 98.7. The likely primary cause was a CA housing tax credit which expired, but which should have produced a short-term peak at the end of the year. I would suggest using the YoY as more indicative, and the western YoY was only down 0.9%.

Personal Income And Outlays In January

Surprisingly, a lot of people seem to have forgotten about the December tax changes when projecting January personal income. For example, the Bloomberg consensus was for an 0.4% increase? Odd, odd, odd, considering the 2% decrease in FICA taken out of worker's paychecks, even though there was an offsetting tax increase for the bottom 40% of earners.

The January change in disposable personal income (DPI) was affected by two large special factors. Reduced employee contributions for government social insurance, which reflected provisions of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, boosted personal income in January by reducing the employee social security contribution rates (employee contributions for government social insurance are a subtraction in the calculation of personal income). The January change in DPI was affected by the expiration of the Making Work Pay provisions of the American Recovery and Reinvestment Act of 2009, which boosted personal current taxes and reduced DPI (personal current taxes are a subtraction in the calculation of DPI). Excluding these two special factors, which are discussed more fully below, DPI increased $11.4 billion, or 0.1 percent, in January, following an increase of $48.5 billion, or 0.4 percent, in December.

As I pointed out last year, the December tax deal boosted taxes on about 40% of earners, but sharply reduced taxes on higher earners. BEA calculates that absent these factors, the reported increase would have been about 0.1%. What is much harder to assess are state and local tax effects. BEA gets the data much later on those. From my sampling, it appears that state and local taxes and fees plus property taxes are still generally ratcheting up, so if anything, I think real incomes are a trifle overstated.

With these factors, current dollar personal income grew 1.0%. Current dollar disposable personal income (after taxes) grew 0.7%. Real dollar personal income grew 0.4%. (Higher income workers received more wages, but lower income workers received less because their federal income taxes were increased due to the expiration of the MWP tax credit.)

Real PCE -- PCE adjusted to remove price changes -- decreased 0.1 percent in January, in contrast to an increase of 0.3 percent in December. Purchases of durable goods increased 0.3 percent, compared with an increase of 1.2 percent. Purchases of motor vehicles and parts accounted for most of the increase in durable goods in January and in December. Purchases of nondurable goods decreased 0.2 percent in January, in contrast to an increase of 0.1 percent in December. Purchases of services decreased 0.1 percent, in contrast to an increase of 0.2 percent.

Again, cars carry the whole shebang. In a lot of ways this exemplifies the current situation. People who were doing pretty well (household incomes 60K - 75K) will do better this year. People who were doing quite well (household incomes 75-110K) are going to have a very good year. People who were at lower incomes are generally facing higher costs and net lower incomes on average.

There is also the unfortunate reality that many workers will exhaust their unemployment benefits this year, and jobs are not plentiful. There still seem to be 4-5 jobless for each job opening.

So now we wait. If job growth can continue, then the bottom echelon can start climbing out of the ditch. If job growth remains relatively weak, a growing proportion of the population is doomed to show up on the food stamp rolls. My guess is that too many low-margin businesses are going to be experiencing additional margin constraints to generate the type of job growth we need.

I also think we made a crucial mistake; giving people who already have very good incomes a very significant rise enables them to spend more, which dampens the underlying signal and produces more inflation. The pricing function is critical to prevent economic imbalances from developing. Futzing around with it in this way generally produces bad results.

In the spring I am expecting spending on nondurables and services to stabilize somewhat, but it depends on the inflation picture which is very volatile right now.

As a general rule in the US, when 60% of households are forced to cutback on spending for a long period of time because of income effects, a recession results. It doesn't happen quickly - the effect shows up in business spending first as they adapt - but it does happen pretty reliably. I think the business effect should be muted this time, because there have already been significant cutbacks in business spending, meaning that job effects will be muted. I do expect to see it show up in business spending and in compensation paid to workers. So I project a slow but more widespread income effect developing.

I assume that the FICA tax will be restored to normal levels in 2012, but the combination of the tax increase and the real drop in incomes for lower earners will produce something of an economic backlash.

Will Congress continue the FICA tax cut in 2012? It is an election year, and it is rare to see significant tax increases in an election year.

PS: The role of certain types of regulation in impairing small business growth is real, but still unaddressed. See, for example, Bill Frezza's excellent article on privately held business startups and Sarbanes-Oxley for a tale of extremely counter-productive regulation.

Friday, February 25, 2011

GDP Q4 2010 Still Weird

But how we get there is still odd-looking; if you go to Table 3 (page 7) we've got PCE up 95.3 billion (durables 57.6 billion), Gross Private Domestic Investment down112.3, all of which stems from an inventory drop of 114.3, although inventories were almost unchanged in aggregate over the quarter (the previous quarter had a strong build), net exports up 110 billion (after deflation, before adjustment net exports rose 57.5 billion), and -9.9 billion for government spending (-9.1 of which stemmed from state and local cutbacks). All of that ends up at an increase of 91.6 billion after price adjustment, meaning that the net export and inventory adjustment swings canceled each other out.

Click on this to open it up. You can see that we still are not nearly back to 2008 totals in wage and salary payments, dividends and interest income, although we are getting closer. 2008 was the first full recession year so it's not a very difficult comparison.

Personal income ex current transfer payments ended 2010 at an improved 9.3 trillion compared to 2008's 9.6 trillion. Because personal transfer have increased over 450 billion we come out ahead in disposable personal income.

This is why budget projections are acutely sensitive to economic expectations. If more of us work, more of us pay taxes and the all-important "social insurance contributions". As people lose unemployment benefits this year current transfer payments will probably drop even with more retirements. Also some will be back at work and not need other support programs.

Thursday, February 24, 2011

CA - The Little Hoover Commission

To cover the story that the press isn't covering, here is The Little Hoover Commission's report on CA public pensions. The Little Hoover Commission was founded in 1962 and has statutory responsibilities in CA; by law it is bipartisan.

Their recommendations are to cut pensions for current retirees to make up the shortfall and stop stupid practices such as using short-term gains as a reason to stop the pension contributions. The report is 106 pages, so I am just going to post their main recommendations:

Recommendation 1: To reduce growing pension liabilities of current public workers, stateand local governments must pursue aggressive strategies on multiple fronts.- The Legislature should give state and local governments the authorityto alter the future, unaccrued retirement benefits for current publicemployees.- State and local governments must slow down pension costs bycontrolling payroll growth and staffing levels.

Recommendation 2: To restore the financial health and security in California’s publicpension systems, California should move to a “hybrid” retirement model.- The Legislature must create pension options for state and localgovernments that would retain the defined-benefit formula – but at alower level – combined with an employer-matched 401(k)-styledefined-contribution plan.- The 401(k)-style component must be risk-managed to provideretirement security and minimize investment volatility.

Recommendation 3: To build a sustainable pension model that the public can support,the state must take immediate action to realign pension benefits and expectations.- To provide more uniform direction to state and local agencies, theLegislature must:- Cap the salary that can be used to determine pension allowances,or cap the pension, at a level that is reasonable and fair. Oncethe employee exceeds the threshold, employees and employerscould make additional retirement contributions into a riskmanaged,401(k)-type defined-contribution plan.- Set appropriate pension eligibility ages to discourage earlyretirement of productive and valuable employees.-Set a tight definition of final compensation, computed on basepay only, over a five-year average to prevent and discouragepension “spiking.”- Set uniform standards for the maximum hours that retirees canreturn to work and continue to receive public-sector pensions.- Set uniform standards and definitions for disability benefits.- Restrict pension allowances to exclude service in an elected office.- Eliminate the purchase of “air time.”- Strengthen standards for revoking or reducing pensions of publicemployees and elected officials convicted of certain crimesinvolving the public trust.-To minimize risk to taxpayers, the responsibility for funding asustainable pension system must be spread more equally amongparties.- The Legislature must prohibit employees and employers fromtaking contribution “holidays,” except under rare circumstances.- The Legislature must prohibit retroactive pension increases.- The Legislature must require employees and employers toannually adjust pension contributions based on an equal sharingof the normal costs of the plan.- State and local governments must explore options forcoordinating pension benefits with Social Security.

Recommendation 4: To improve transparency and accountability, more informationabout pension costs must be provided regularly to the public.- The Legislature must require government retirement boards torestructure their boards to add a majority or a substantial minority ofindependent, public members to ensure greater representation oftaxpayer interests.- All proposed pension increases must be submitted to voters in theirrespective jurisdictions.- The ballot measures must by accompanied by sound actuarialinformation, written in a clear and concise format.- The Legislature must require all public pension systems to include intheir annual financial reports:- The present value of liabilities of individual pension funds, usinga sensitivity analysis of high, medium and low discount rates.- The government entity’s pension contributions as a portion of thegeneral operating budget and as a portion of personnel costs,trended from the past and projected into the future.- The State Controller must expand the Public Retirement SystemsAnnual Report to include the above information. Administrative feesto pension systems should be considered as a funding source tosupport actuarial expertise and the timely production of the report.- The Legislature must require pension fund administrators to improveprocedures for detecting and alerting the public about unusually highsalary increases of government officials that will push pension costsupward.

Some of this is just pure dynamite, especially the part about submitting pension increases to a vote. You think WI unions are upset - this will produce a reaction akin to that which would occur if the Japanese air force poured acid on Godzilla.

Oh, and a footnote:

It is important to note that the Commission did not examine retiree health care costs as part of its pension study. The Commission would like to acknowledge the extensive work of the state Public Employee Post-Employment Benefits Commission, which stressed the need of current workers and employers to share in the responsibility of pre-funding retirement health care costs.

The report is not all unfavorable to the workers, though. It is worth reading to see the games that politicians have played:

During a weak economy that cut into state revenues in the early 1990s, Governor Pete Wilson proposed using $1.6 billion from CalPERS’ accounts to help balance the state budget. Wilson also called for giving the Governor the authority to appoint a majority of CalPERS board members, as well as to control actuarial projections, which are used to determine liability levels and state payments into the pension fund. The Legislature agreed to the changes in 1991 with AB 702.10

That move was blocked by Proposition 162. I thought I'd just throw that in to show that the referendum system in CA has been used at times to address governmental irresponsibility. As the report notes, CA's public retirement system is overall much better off than that of some other states. Still, CalSTRS is going broke around the original SS break time - 2040. And some of the cities are in deep, deep trouble.

At this point in the game I begin to watch the YoY figures more intensely than the monthly, and shipments a little more closely than new orders for some categories. We need a few more months of data, but autos may be capping out and give us little surge the rest of the year:Get a load of the YoY drops in motor vehicles.

I have been wandering through commodity prices. The hot money is in oil and out of other items like most grains, but it is difficult to conceive of stabilizing prices later in the year. The Bundesbank, in particular, seemed to have been placing a lot of weight on the theory that prices would return to a "disinflationary" trend in the second half. That was the common theory; it was really based upon the end of the Fed's QE2 program in June, although no one would admit that.

I have not agreed. Prices are up too much in India and China for that to happen. Nor can I see the ME region really stabilizing this year. Therefore I expect import prices for a lot of consumer goods to keep ratcheting up. There is a pulse of inflation in the system that is really restrained by reality and pricing.

What truly concerns me about commodity price movements in recent days is that they make little sense. If oil is going to be up, the prices of most of those commodities will increase, not decrease. So what the market is really saying is that oil prices are not stable over the long term. No kidding. But that is not a forecast for economic success and prosperity; this means many business horizons are shortening up. So Mr. Packaging Guy is going to remain on the sidelines managing his margins without new investment. Call it the Campbell Soup/Sears effect.

New Home Sales for January were markedly bad. There is too much competition from existing home sales. Oh, and despite recent history, despite common sense, despite the laws of gravity and all else, the Fed has once again timidly been pushing its foot into the "subsidize home purchases for those who can't afford them" waters. The problem with making down payments for people is that you aren't making them save which proves the financial discipline and commitment to home ownership that are necessary to keep a home. DAP programs have proved such a disaster that it is difficult not to lose one's eyeballs when reading stuff like this. But it isn't just this one researcher; the Fed governors have begun cautiously making comments about boosting homeownership and dropping underwriting standards.

Wednesday, February 23, 2011

Wisconsin And Other Financial Stories

Wisconsin: Okay, one of the big battles is over arbitration rules that may sometimes be skewed in the union's favor, and the WEA Trust. The WEA Trust is an insurance company set up by the union; a lot of teachers' contracts require the school boards to purchase its insurance. Which can be pricey. Walker's speech up at Althouse.

I didn't find WEAIC on the HHS Obamacare waiver list, but man, there sure are a lot of union plans on that list. Many of these started with the best of intentions, but money does tend to stick around at the union management level. Sometimes the fund pays bargaining fees or acquisition premiums to unions; sometimes it's a touch more subtle, such as the premium money going through the union into the welfare fund with the union getting the "extra" (individuals who chose cheaper coverage). I suspect that there are so many union plans (this is for the waiver on annual coverage) not because union plans are worse but because they got the waivers first and had "outreach" assisting them.

In other economic news. the last pollyannas have given up trying to claim that home prices in the US are recovering. They are not. Nor is commercial real estate recovering. Both apparent rebounds were statistical artifacts. In residential, the housing tax credit had a lot to do with it.

Existing Home Sales rose YoY; home prices dropped YoY, most especially in the west. Actual reports at this link, if you care. Condo prices fell much harder than single-family. Not surprisingly, condo sales rose much more than single-family. This is all about incomes now; the affordability is pretty good, but fewer persons qualify for the lower-priced mortgages or even any mortgage. Average mortgage rates did drop to 5%, though, and MBA apps came up.

I don't think anyone believes that the ME problems will be temporary. The Saudi King is handing out lots and lots of dough; perhaps Saudi will pump more oil to pay for it, although if the House of Saud can hang on it's going to be getting an economic windfall from the disruptions.

This sort of thing is very good for US Treasuries, and one can see the effect both in short and long yields this week. The wit and wisdom of Stephen Leacock are still relevant. Bund yields are moving both up because of the inflation issues and down because of a gallop to safety; the press is on for rate increases.

The picture for European banks is getting steadily worse; the fundamentals for the individual entities have to be carefully watched. (One wonders if this criminal isn't making an epistemological statement, although bank robbers are not known for their philosophical musings.) The leadership change at Bundesbank just adds a little more uncertainty to the mix; Merkel's candidate will probably support her desire to extend bailouts. However, all the bailout fervor collapses with Italy, and I do not think that Italy will recover. I think Italy needs to resume the lira, although it has plenty of time. It will not do it until considerably later.

The Canadian dollar will probably be helped again, although the strength of the loonie is not helping Canucks export to the US. Industrial metals are falling in price; buyers are taking the energy worries quite seriously.

I have been laughing myself nearly into a coma at the US NY Times/WaPo Axis of Idiocy as they try to portray what is happening in Wisconsin as somehow significant, or in any way parallel to the 1848-sh wave in the ME. It is not. By the Leacockian standard, I guess this qualifies US Treasuries a very good buy indeed, because our national leadership and punditry appears to be drunken fools who are unequivocally citizens of the United States of America.

Tuesday, February 22, 2011

Q4 Wal-Mart Results

Badly reported in this Bloomberg article, but this is what I was waiting for. Q4 same store sales dropped 1.8%. This was way short of the company's own expectations early in the quarter, but as I noted last year, families started their shopping earlier, so later months produced disappointing results (see their own reporting):

Net sales results

Net sales were as follows (dollars in billions):

Three Months Ended

Fiscal Years Ended

January 31,

January 31,

Percent

Percent

2011

2010

Change

2011

2010

Change

Net Sales:

Walmart U.S.

$

71.105

$

71.437

-0.5

%

$

260.261

$

259.919

0.1

%

Walmart International

31.382

28.823

8.9

%

109.232

97.407

12.1

%

Sam's Club

13.113

12.566

4.4

%

49.459

47.806

3.5

%

Total company

$

115.600

$

112.826

2.5

%

$

418.952

$

405.132

3.4

%

See the prior post below for more on WI, businesses and the fiscal picture.

Monday, February 21, 2011

The Poker Rules For Businesses

I found your comments on the last post really interesting.

The first thing I wanted to address would be the topic of business taxation (and capital gains) - one of the topics that came up was business taxation, and that lower taxation might not create jobs. That's both true and untrue. In general, cutting marginal tax rates does tend to create jobs, but I would be highly suspicious of our current system of specialized tax breaks combined with high marginal tax rates.

It's like poker. A good poker player knows the odds of winning with the hand she's got. But in each successive decision in a hand, it's not just the odds but the money that is in the pot and the investment required to get the chance of winning along that underlie the decision to stay in or get out.

An example:You have a hand that gives you a 1 in 4 chance of winning. There are eight dollars in the pot. You have to pay three dollars to stay in. If you did this four times, you'd win eight dollars (on average) and you'd have paid 12 dollars for the privilege. Not a good business plan!

But suppose you have the same hand that gives you a 1 in 4 chance of winning. Once again, there are eight dollars in the pot. This time, you only have to pay one dollar to stay in. If you did this four times, you'd win eight dollars (on average) and you'd have paid four dollars for the privilege. A very good business plan - provided you have the necessary stake (capital) to keep playing. That's what poker is about.

Business works very similarly. Businesses are constantly trying to decide whether to invest more money, not invest but continue in business, or whether to fold (stop putting in money and shut down the business). The odds they calculate are based on their knowledge of their business fundamentals and the external economy. However marginal tax rates determine how much money is in the pot, which changes the amount of investment the business will consider. Businesses' assessments of uncertainty also vary over time with the economic climate, which may change their calculation of rates of future return on investments. And then there's tax policy.

Higher marginal tax rates are particularly effective in suppressing business investment and job creation in higher risk environments, and even more so when a lot of capital has to be invested to produce the jobs. They reduce the size of the pot. Suppose in the examples given above the house took 50% of the pot. In the first example, our poker player would now be paying $12 for a return of $4. In the second example, our poker player would be paying $4 for a return of $4.

An example:You have a packaging business. Your business has emerged from the depths of the recent downturn with about a 20% increase in business and is making some profit again. You have no loans. However your machinery is not that flexible, and orders aren't picking up that much more. After beating the bushes for business, you find that you can definitely get considerably more orders if you can package much more flexibly with smaller sizes, due to the needs of consumer companies to keep their units of sale below certain price levels (i.e., there is a much bigger demand for 10 ounce packages that used to contain 12 ounces).

Now you are faced with a decision. You can spend 500K to upgrade your machinery net installed, but tax law will require you to amortize that cost over 10 years. You almost certain that you can get enough new orders with the new equipment to net you an extra 100K in before tax profits each year over the next two years. You might net 125K after the first year. You suspect that you are going to be paying more for utilities over the next decade, so you are not sure about maintaining your profit margin after that. But you think that you will be able to continue to expand your business at least somewhat in the next five years, unless there is another significant downturn.

You don't have the 500K. You have about 100K in your capital fund. The company offers a lease deal over 7 years, with option to buy, but it is effectively going to cost you 10%. You can get a loan from the bank with a lot of irritating paperwork and covenants for 75K down (borrowing 425K) at 5% going variable after 2 years to 1% plus prime rate. Plus it's a UCC everything, meaning that if you don't pay, the bank can seize and sell all your equipment plus all your business accounts. And the covenants are sure irritating, you have to give the bank quarterly financial statements plus updated lists of frigging assets as long as you have the loan. Yuck.

Your interest is going to be deductible from profits, and for the first year it is about 21K. Your annual loan payment is about 54K. Simplifying, let's assume that you are allowed to deduct the capital cost of the equipment equally over 10 years. That's 50K a year. You deduct interest on the loan. Your marginal net income tax on the extra income (state, federal, local) is at 46.9% (see federal & WI). So 100K - 21K - 50K = 29K * 7.9% WI = $2,291. Federal = 39% * (29K - 2.3K) = $10,416. Extra taxes of $12,707.51.

So your first year cash flow is 100K (extra gross profit) - 54K (loan) - 12.7K (taxes) = 33.3K. That's not great. You have to replenish your working capital, and it looks like it will take you close to 3 years to do that. The tax bite will increase in later years as your deducted interest drops. This is a very questionable move. Yes, you may make the extra 25K in gross profit in the second year, but that only nets you another 15K. You've assumed a lot of risk and fixed expense with that loan.

This is one reason why administrations usually put in expensing of equipment during and right after a recession - the ability to expense equipment creates a lot of new investment. (Expensing equipment allows you to deduct the total cost in the year you buy it, or more of the cost.) It crashes corporate taxes, although it does tend to keep up personal taxes.

The tax rates I cite are accurate. US federal corporate tax policy is lunacy squared. For profits between 75-100K, it's 34%, then for 100K-335K it's 39%, then it goes down to 34% for 335-10 mil, then up to 35% for 10-15 mil, then to 38% for 10-18.3 mil, then down to 35% for over 18.3 million. You can also choose to be taxed as a pass-through in many cases, which would net you lower taxes in some cases. And federal corporate income is reduced by state and local corporate taxes (in the US, the state and local tax adds up to over 16% in some places), so in effect we subsidize states. But then, we also tax all income of domestic corporations no matter where it is earned, although we give a credit for taxes paid elsewhere. Most countries only tax domestic income. More info.

Capital gains taxes are yet another football. In a lot of ways, capital gains taxes are a tax on inflation. Just as eliminating the capital gains exclusion for the first 500K of a person's primary residence would cause many persons to take a net loss if they bought a house, paid it off, and then sold it to move into a retirement home in their later years, corporations are also forced to engage in many bizarre transactions solely for tax reasons.

Because pass-through taxation rates are often lower on net, a great number of businesses elected to go pass-through. And that means that we now cannot raise personal income tax rates very much without really hurting business investment and job creation.

And now, Sporkfed, listen up. Because I know you just don't want to hear this:

This guy in the packaging business? He has about 50% chance of surviving the next seven years if he does this. If he is in his later 50s, he shouldn't do this. Because if we even have a downturn in 2013, much less a real recession, he probably won't be able to make that loan in 2014. And when he doesn't, his banker essentially owns his entire business. Everything the guy has worked for he loses.

No, what Packaging Guy, who, given demographics, is likely in his 50s, SHOULD DO is tighten this thing up, conserve cash, and pretty up his balance sheet. And then he should look to sell out in the next couple of years. And by "tighten up" I mean cut employee costs, and not put ANY money into the business that doesn't pay back within two years.

And if you look at what businesses are doing, that's precisely what is happening. Because margins are declining, uncertainties are mounting, and the reality is that many business owners are nearing retirement and shouldn't be taking risks of getting cleaned out. The more capital you would have to put in (the higher the bet), the greater the uncertainties.

Look at what Packaging Guy is really facing. He's got employees. To really make his buck back on the new investment, he needs to expand hard, and that means he has to hire new employees. And with the health care reform, that may be terribly costly. It's an uncertainty for businesses who have 20-40 employees, that's for sure. A rise in general tax rates is almost certain, given the fiscal problems. His power costs are going to go up. If he's in WI, his heating costs are going to go up. Insurance costs per employee are going to go up. There are going to be all sorts of little state and local fees and goodies and licenses and audits. And then there's regulations. Lord, the regulations. The larger the business gets, the more regulation, and oh, the joy of potentially running into new CO2 standards. Face it. Mr. Packaging Guy ain't gonna decide to be a Real American Hero and expand.

If, through tax policy, we change the equation enough, Mr. Packaging Guy might. But note that the expensing provisions, for example, really help the larger corporations more. They get a much higher net payback on average because they have more profits! The worst of it is that our current policies really favor expansion in larger corporations, but the larger the corporation, the more likely it will choose to funnel some of the returns overseas in better business environments.

Practically all the "socialist" European countries have gone to a low corporate income tax rate with much higher personal income taxes. Try this. They have done so to create jobs. Check into Finland and Sweden and Denmark and Austria and China and France and Germany. And think. Think HARD. Spain's corporate income tax is 30%, but there is a special low, low recession rate right now of 20% for some small companies. The world changed, and we did not change with it. Australia's at 30%.

This is Wisconsin's labor and employment data at BLS. How do these graphs look to you?Part of WI's problem is that its population is a couple of years older than the US population, so it will hit the retirement hump more quickly.

This is somewhat apparent in the labor force stats. The labor force graph is almost flat from 2003 if you ignore the recession hump.

But clearly, the drop in jobs since 2003 means that a lot of jobs must be created to get back to par. Since December 2003, the percentage of non-farm workers employed by government has risen from 14.77% to 15.65%.

Government workers were 411.0 in December 2003 vs 427.3 in December 2010.

One of the things Wisconsin must do is to increase its private jobs. Over the course of the last "recovery" six months, total non-farm employment rose from 2728.8 to 2731.0, but government jobs rose from 422.6 to 427..3. In other words, non-farm private employment dropped. WI can't keep going like this.

People are talking about our current problems with all sorts of rhetoric, but very few are dealing with the mathematical problems. Talk about justice and fairness and sharing and sacrifice won't get you anywhere if the numbers aren't there.

Saturday, February 19, 2011

New Rule For Myself

New Rule: If Ezra Klein agrees with me, I must be wrong!

Sigh. I suppose this post is really about my own stupidity, which is such a deep and broad subject that I tend to avoid it. I am running like a squirrel on a wheel who has just been assigned to provide renewable power to several major NA cities, and I haven't had much time to read this week. That's one excuse.

To proceed to the main confession, I had glanced at the WI kerfuffle over state unions, and I had vaguely formed the impression that it was a bit of grandstanding for political effect. Then I read Ezra Klein's opinion on the subject, and I began to suspect that I might be a bit of an ass. Sadly, when I have developed such suspicions before they have usually been confirmed, so....

I did a little research. The meme that the Ezra's of this world have been pushing is that Wisconsin really doesn't have a budget problem and that they are just seizing the opportunity to take it out on the unions. Pew's report on the states from 2009 lists Wisconsin as one of the 10 most fiscally worrisome states. Not a good sign. Sunshine Review for Wisconsin told me that WI does a two-year budget (like Texas), that WI had already raised taxes, hiked fees, etc, and that they are slated to run a 3.6 billion dollar deficits for the next two-year budget.

In short, they've already eaten the low-lying fruit, are losing the stimulus state payments, have already furloughed, etc, and are facing a short range hike in deficits that will never clear due to oncoming retirements.

Wisconsin law requires the adequate funding of pension benefits, but no such law exists for State employees’ and teachers’ retirement and healthcare benefits. The Institute’s study found obligations related to these benefits total more than $1.6 billion. This is a result of years of over-promising retirement benefits, while shortchanging funding. Since retiree’s healthcare benefits are not immediately payable in cash, Wisconsin’s politicians ignore these payroll costs when calculating “balanced” budgets. As of June 30, 2009, the State had set aside only 22 cents to pay for each dollar of healthcare benefits promised. As of that date only $450 million was deposited into the healthcare retirement systems, even though the actuaries calculated that a minimum of $2.03 billion should have already been contributed.

Apparently the employees currently contribute almost nothing to retirement and medical benefits. Once again, union management has gained promises by negotiating benefit packages without requiring funding. If they had required funding, it's a good guess that the WI taxpayers would have already demanded the payments.

As to whether the collective bargaining limits are fair or not, I don't know. But it is clear that the unions have been irresponsible, and so have successive administrations. So far the Ezra Klein rule is working well for me.

PS: Ann Althouse is blogging steadily on the whole thing. She has skin in the game (she estimates the proposed changes will cost her 10K a year).

PPS: Offered by commenter Rick Caird, a PolitiFact Wisconsin examination of the WI budget surplus meme. In any case, what's really at stake is the next two-year (biennial) budget. Not that they aren't in at least a 400 million dollar hole right now.

It is devastating to contemplate the unending sea of red ink some of these states face.

WaPo Got Pushed Too Far

Wednesday, February 16, 2011

Chris Christie In Washington At AEI

Here's a video of the speech. It's worth watching, although it's long. Audio only here.

The big guy makes some good points in this one. Most of it's a call not to be wimpy and to do the right thing. The man is not glib. I was trying to figure out who he reminded me of, and it's Teddy Roosevelt, who once got shot, gave his speech anyway, and then went to the hospital to get the bullet removed.

He's dead serious about fiscal reform, and as he points out, Democratic or Republican, a lot of governors are facing the same realities and having to resort to the same solutions.

Republicans Can Read

"What my budget does is to put forward some tough choices, some significant spending cuts, so that by the middle of this decade our annual spending will match our annual revenues. We will not be adding more to the national debt," he said.

Hey, didja know I can fly? I just don't, because I don't feel like it, but I sure 'nuf can fly. Also I can balance the budget, as long as you don't mind me borrowing to do it!

I can hardly believe that they think the public is this stupid. Even Congress Critters aren't that stupid, although they are famed for not reading the bills they pass.

If you have doubts about whether the president and the administration are telling the truth, you can go to the summary tables as posted at whitehouse.gov, and see page 3. You will note that debt held by the public is slated to rise some 864 billion between 2020 and 2021. This isn't a subtle lie. From 2018, the deficit is slated to rise to 3.0% in 2019 and then 3.1% in 2020 and 2021.

Then if you go to page 34, you see that they expect nominal GDP to be 24.9 trillion, and total debt (not just held by the public, but including the IOUs in the SS trust fund) to be 26,346 (page 35). In short, they expect public debt to be more than 100% of GDP in 2021. (September 30th, 2021).

If you want to compare this to CBO's last effort, you'll see that CBO uses more negative economic assumptions to get to about the same result.

The Chinese rebalanced CPI to include more of a housing component.The PPI is clearly not going to last at this pace. Housing costs are going up very fast:

The price of articles related to dwelling expanded 6.8 percent over the same period of the previous year. Of which, price of water, electricity and fuel, construction and decoration materials, and housing rent was respectively climbing 3.9, 4.3 and 7.1 percent.

It's not a great time to be lower income in China. There is still a lot of the old government housing available, most at low rates. But look at the food prices!

US PPI: The 12-month on crude goods is 10%, on intermediate goods 6%, finished 3.6%. That is unadjusted.

US Housing starts for January: This is being touted as good news, but I don't see it. Multi-family starts are up 80/81% compared to December & YoY, which made the starts index look good, although still down YoY. But under construction is still falling, completions are falling, and even with the rise in multi-family starts it looks like the overall pace of activity is doomed to keep falling for most of this year (multi-family starts, even with the big rise in Jan, have fallen from 192 to 159 over the last year). Authorizations (permitted/not yet started) were down again. Multi-family authorizations were down about 10% both MoM and YoY. There was a sharp increase in December for multi-family permits. These tend to go in spurts, and the projects usually take years to complete.

After all, we really don't need that much more housing. However I guess the good news is that construction pace will probably drift down in 2011 instead of collapsing, although that shift really took place a while ago. We shifted into drift territory around last summer. Housing activity is at such an amazingly low pace for the US historically that the data is very noisy, and even a big relative increase of 5-10% wouldn't mean much. Go look at this chart - we're talking nuthin'burger.

Industrial production fell very slightly in January, although I wouldn't put too much weight on it. If you look at the details, the declines were centered on construction and utilities (people turned off their Christmas lights). Given the unusually bad weather south, that is not a surprise. No capacity growth over the last year. That's for both total industry and total manufacturing.

One thing to remember about this report is that the sample is not statistically representative. See documentation. They do probably capture most of it, though:

The industrial sector, together with construction, accounts for the bulk of the variation in national output over the course of the business cycle. The industrial detail provided by these measures helps illuminate structural developments in the economy.

Utility data should be pretty good, so you can use that as a parity check on the rest of it. Over the entire year, utility production only rose 0.1%.

This is not to say that manufacturing activity isn't picking up. It is, but not at the pace that you would expect if you just read the ISM/PMI/NACM reports, which are biased upward because some companies have gone bankrupt and some production has been shifted off-shore. There's a conservation effect in the utilities figures; a lot of people and many companies are using much more efficient lighting. But the mere fact that utility production dropped sharply in October, rose decently in November (store displays), shot up 4.1% in December and then fell 1.6% in January (these are seasonally adjusted figures!) tells you something about the split between industrial production and retail/household power usage, and what it tells you is that domestic production isn't rising that fast.

Rail data in January continued to show healthy YoY gains. It's worth noting that a distinct downward trend in Canadian rail traffic has developed and firmed. Probably this is due partly to currency effects. The US ATA tonnage index rose an originally reported 2.2% in December, since revised down to 1.3%, and 3.1% in January, so that's a positive. In other news, ATA is irked at the Obama administration over hours of service rules.

MBA purchase and refi apps continue their inexorable downward climb. Last week's average rate of 5.13% dropped to 5.12%. It appears that more would be needed to generate a shift in trend. I live in fear of the discussions probably happening up in the Fed Ivory Tower over this issue.

If you have bravely staggered this far through the post, you deserve something for your efforts.

The second made me spill my coffee this morning, although it is not meant to be comedic. Our president's grave call to limit the rise in Medicare and Medicaid costs was made in a state of apparent blissful ignorance of the fact that it is health care reform which is going to cause a great deal of the rise in Medicaid costs:

President Barack Obama said the rising cost of Medicare and Medicaid is creating “huge problems” for the nation’s finances that must be dealt with “in a serious way.” He’s just not taking the first step.

In his Feb. 14 budget proposal and at a news conference yesterday, Obama said the entitlement programs were driving the U.S. debt, while offering no details on how to shore them up.

Also unmentioned is that the mandated increase in Medicaid rolls will greatly increase cost-shifting to the privately insured, so this is a business issue and a barrier toward increasing employment.

I mean, if you are going to get slapped with a 2K fee for insurance for every wait person, busbuy, etc, aren't you going to limit the size of your restaurant? See Snarky Mark. Just imagine that that graph is going to look like in 2018.

Tuesday, February 15, 2011

US Retail Sales, Jan

The YoY aggregate numbers are still great, but remember these are not adjusted for inflation. The month-over-month is not so good. December's revised numbers are +0.5 from November, and January's preliminary is +0.3 from December. That will be revised, however, and truthfully this report's error bars are higher than that 0.3. So we don't know. It could really be a much healthier 0.5 or it could be zero or it could, theoretically, be negative although I don't think so, given pricing trends.

What should give us all pause is the segmentation in the categories (see Table 2)Autos: +15.7 YoY, +0.5 MoM.In the highly discretionary categories for January, we racked up the following string of negatives:

Furniture: -0.3.

Building Materials & Garden: -2.9

Clothing: -0.3

Sporting & Hobby: -1.3

Restaurants & Bars: -0.7

Electronics was okay at +0.3

That's not a particularly good score. In the highly necessary categories:

Groceries: +1.3

Pharmacies: +0.5

Gas: +1.4

I am expecting the positive auto trend to keep going, because after sales have been suppressed for years, there is built-up demand. This moves autos to a highly necessary category for more households.

Overall, I am not too happy with the spending pattern that has been developing over the last few months. It seems to indicate that we are seeing 2007-like changes in buying patterns. I am expecting this to get a bit worse before it gets better because of increasing losses of unemployment benefits and inflation.

This winter has been cold for many and is causing high heating costs for many. Although the weather in January was generally unfavorable for shopping in northern areas of high population density, the same was true of last January. On a YoY basis, electronics and appliances store sales dropped 0.3.

Over the course of the last year, retail sales rebounded hugely. It's doubtful that we will see the same trend this year. As long as auto sales can hold out, the economy shouldn't re-contract. It's too big a vector.

I don't know, I looked at this and it gave me the willies. I wasn't too disturbed by December's performance, because a lot of people DID do considerable holiday shopping early. There is more inflation for basics that must emerge in the next few months.

The unknown variable is barter and the gray economy. By this stage a lot of people should have worked out sources of income and exchange that aren't showing up in official stats.

UK inflation went to 4% in January. Germany only went to 2%, which isn't bad. European inflation was at 2.4%. We're just about to get US January numbers, but the 2010 final was 1.5%, 1.7% for CPI-W (lower income). Rural is much higher, and the less income you have the higher it is. Currently, many northern lower-income households are seeing YoY inflation rates on the order of 7-9%.

Through December, real retail sales had risen greatly in 2010 (see St. Louis Fed Fred). I don't think this trajectory will continue through 2011:

We are, of course, still off the pre-recession peak. It would take over a year of pure stagnation to pull us into another slow contraction.

If I am right about auto sales, we won't see stagnation this year.

Assuming the Fed doesn't get inflation under control by the end of 2011, believe it or not, I have the most likely scenario being for us to go back into recession right about the end of third quarter in 2012 (Thanks, Brian).

Remember, my dating on these things always looks early, so most sources wouldn't admit it until about the end of spring of 2013. With any luck, it will be a short one caused by inventory and lasting from about 7-9 months.

What produces this are current car sales, the Bernanke attempt to defy the economy law of gravity, and the rather witless tax deal worked out last December, which shoves a lot of tax rebates right into the top segment of the population. And they'll spend it, which will reinforce the inflation cycle. In the meantime, incomes will be eroding from the bottom up.

Then when the payroll tax goes back up in 2012, we'll wind up with a short-cycle effect.

That's highly preliminary, though.

I am unhappy about the continuing high demand for six month treasuries. The one month I can see, the three month is high, but coverage of 4.72 on the six month is not forecasting a very strong investment cycle in 2011! No matter how much I try to convince myself that this is partly due to retraction from longer money to shorter money, I'm just not comfortable with this.

I look at commercial paper for non-financials and I don't get the warm fuzzies:Yeah, it has to do with the inventory cycle, but still.

There was a big January pay down on revolving consumer (non-RE) debt at banks in January. That's a seasonally adjusted drop of 13.4 billion dollars or 26.8% annualized (don't worry, that won't continue). So people charged some and paid off more. Banks hold close to 3/4s of revolving consumer debt, so that sudden change in January revolving consumer credit people were talking about wasn't a change at all - higher-enders charged holiday purchases and then paid them right off in January.

The inexorable rise in Other deposits paused in December and then resumed in January. It looks like home sales got a boost at the end of the year due to large drops in Large Time Deposits, but that has ended. I'm guessing a lot of this was from people like Ron pulling money to bail out the kids or provide a large enough downpayment to qualify for a lower rate.

Monday, February 14, 2011

Reading the Budget

The meat of the whole thing is in these tables in this segment. Only 36 pages, pdf. If you want to read all the fluff, it's available here. There's a lot of words and not that much substance in the wordy sections.

There's some money for the states in the form of an expansion of the Build America bond program.

But here are the economic assumptions:You know the deal. Right click or left click, and open the thing up to get something readable.

The ten-year treasury bill is assumed to be 3.0%. It's yielding 3.62% now.

Assumption is that the 10-year will rise to 5.3% in 2017 and the 3 month will go to 4.1%, and there they'll stay.

GDP growth is assumed to be 2.7% this year (real), and rise to a height of 4.4% (real) in 2013, afterwards stepping slowly down to 2.5% in 2019. 2012 3.6%. There is a disagreement with CBO on this.

Debt held by the public is supposed to rise 1.838 trillion in 2011 and 1.025 trillion in 2012, but they're listing debt held by the public in 2013 as only 12.784 trillion. According to Treasury Debt to the Penny, debt held by the public is 9.455 trillion as of 2/11/11, and ended 2010 at 9.39 trillion. However budgeting is done by fiscal year, and as of Sept 30th, 2010, debt held by the public was listed at 9.022 trillion. Yes, folks, we have ratcheted up public debt over 430 billion since last September.

As a percent of GDP, individual income tax receipts are projected to rise from 6.2% of GDP in 2010 to 9.9% of GDP in 2021. That requires quite some tax increase. By 2014 they are supposed to rise to 8.5% of GDP. In terms of nominal dollars, individual income taxes net are supposed to rise from 899 billion in 2010 to 2,439 billion in 2021. They are estimated at 956 this year. Social Security taxes are projected to rise from 559 billion this year to 1,109 billion in 2021. Basically they are figuring a very big rise in wages paid over the decade.

Social Security payroll taxes this year are estimated at 559 billion (remember, these are fiscal years), with outlays of 742 billion. That includes the payroll tax cut, so it is not representative. SS payroll taxes are estimated at 1,109 in 2021, and outlays are estimated at 1,269 in 2021, for a net deficit of 160 billion. Since by 2021 debt held by the public is supposed to reach 18,967, I doubt anyone is going to want to lend us that. Gross federal debt is supposed to be at 26 trillion plus in 2021. Kind of a daunting figure which includes the increasingly mythical trust fund balances.

Net interest on the public debt is projected to rise from 196 billion last year to 844 billion in 2021.

Energy: There are a whole bunch of tax increases on fossil fuels. Expect the cost of gas and electricity to rise to compensate. See the bottom of pages 21 and 22, and pages 17 and 18. He really was serious about bankrupting coal.

Businesses: There is a big tax increase for companies in the form of repealing LIFO (last in, first out) accounting. Estimated tax increase for just 2014 is 5.6 billion. Page 16. There is something called a "financial crisis accountability fee" which is going to be a tax on investments. 4 billion a year.

Some of the proceeds from taxes on fossil fuels are going to "cool" businesses:These numbers are in millions, so the ten year net for the research, experimentation etc is 106 billion, and it's 3.6 billion for qualified property used in a qualified advanced energy project.

We are also wanting to spend 5 billion on wireless broadband. Because that's cool. That's sooo cool.

This Will Make Us All Go Gray

Net interest expense will triple to an all-time high of $554 billion in 2015 from $185 billion in 2010, according to the Obama administration’s adjusted 2011 budget. ...Debt-service costs will climb to 82 percent of the $757 billion shortfall projected for 2016 from about 12 percent in last year’s deficit, according to the budget projections. ...“People are starting to come to the conclusion that you’ve got a self-sustaining recovery going on here,” said Thomas Girard who helps manage $133 billion in fixed income at New York Life Investment Management in New York. “When interest rates start to go back up because of the normal business cycle, debt service costs have the potential to just skyrocket.

The problem with this is that we will not be able to do much about our deficits. From now until then, spending even more money on stuff that isn't demonstrably going to produce more efficiencies will only make the impending social services cuts that much more draconian.

On a previous post, Dan left the following comment:

Fascinating discussion, especially for a liberal Democrat like myself. I think there's a case to be made for some regulation (unless we want to go back to the era of 80 hour work weeks and child labor), but I agree that we can be over-regulated. Everyone (and I mean *everyone*) sees the government as a tool to do what's best for them, rather than for the country (an unfortunate by-product of the cynicism of the Republicans since the 1980s as well as actual failings of government).

What's striking to me is that some people in this thread seem to think that we can race to the bottom--if we only cut taxes and make business less regulated, we'll revive our manufacturing. Not happening, folks. Any amount of taxes we cut, the Chinese (or Vietnamese, etc, etc) can cut by half again. Plus, I think that Americans are wealthy enough to not want those 'dirty' industries mentioned. And guess what? When a country gets rich enough, the citizens tend to make that decision.

We need to compete based on our comparative advantage--agricultural wealth, innovative society, wealthy consumers, educated workforce, legal structure, and large domestic economy. I don't know how to do that best, but I do know that the government has incentive to improve these comparative advantages, as opposed to (largish) companies, which have very little incentive to care about locality.

I guess it's a matter of trust. I dislike trusting either big business or big government, but if I have to pick one, I'd say government--at least you can vote the bastards out.

And then, I guess the answer always comes back to politicians--I wish we had a smaller republic where politicians would be more responsive.

There is a lot here most can sympathize with. Politicians do not seem to be very responsive to our most pressing problems. Dan is certainly right that most people are asking the government to operate in their own interests, without regard to whether it would be sustainable over the long run and whether it would hurt others severely.

But some of this.... Dan thinks government has an incentive to improve local conditions, and that it will invest our money more wisely than corporations. But as far as I can see, much of our current proposals amount to giving large amounts of our money to these corporations which Dan does not trust. There's a contradiction here. Nor has much of the "giving-money-to-corporations" initiative worked; all that money given to solar has just been shipped overseas. The problem is that if corporations can't make money doing it, the government can't make money doing it either.

The worse fallacy we currently aren't facing is how close to the line of irreversibility we have come.

According to the Treasury prediction, net interest on publicly held debt will rise to about 550 billion in 2016. Just to show how serious that number is, here are some details on US fiscal year receipts all expressed in billions and trillions. 550 billion is .55 trillion, compared to 185 billion or .19 trillion in 2010. The difference is .36 trillion or 360 billion.

So, even assuming that by 2015 taxes have rebounded far past the peak level of 2008 (let's say 2.6 trillion, which we are in fact unlikely to achieve), it is clear that the pace of growth for Medicare, Medicaid, and Social Security will race past tax receipts. ( I will pretend that we did not pass health care reform, which is a huge new entitlement program.) CMS expenditures will start rising very rapidly after this year, because each year a large new cohort of retirees will reach 65 and go onto Medicare. In just two years, spending on these two programs rose from 1.52 trillion to 1.79 trillion. The rate of growth is due to increase, but let's pretend that spending will only increase by .30 trillion each two years.

By 2016, we will be spending over 2.6 trillion on these programs - which is definitely more than revenue from the three main revenue streams. Note that this was not true even of 2010. Add the .36 trillion for the additional interest, and you come up with 2.95 trillion in 2016 spending for interest on the debt, government medical and retirement. US corporate tax rates are already about the highest in the world. So forget that. You would have to raise income tax rates so high to cover just the interim needs that it would cause a second downturn. The problem is the ratio of wage earners to retirees; we can only make this up by charging much higher rates on investment income, but that is essentially a direct cost levied on capital.

So the 2016 split looks very negative. Dan commented on trust. The fiscal realities are so brutal that I think trust in government will continue to decline. Even this year Pelosi was lying to Democratic voters (no one else believed her) about Social Security.

We now have to cut Social Security and massively cut Medicare. There is no option. And we have to do it before 2020.

We have to raise (and we have already raised some) taxes on investment income.

Our government has lied to us, and the lies are inflicting a brutal awakening upon the American public.

In terms of trust, the GOP will gain more and more, because GOP leaders have been much less culpable in maintaining the illusion, although they certainly haven't delivered legislative solutions when they had the chance to do so. But Congress, as an institution, will only become less and less credible until the current crop of leaders are out and a new crop is in. This may account for the brawling-over-the-last-public-dollar syndrome we see demonstrated in current politics. If everyone knows we're lying, everyone wants to make sure that they are not first in line for the axe.

To regain trust, we at least have to start legislating in the broader public interest, but until we do, trust in government will keep collapsing.

The problem with the health care reform act is not whether it is constitutional or not. It is that it was never fiscally possible, and it will not be the law of the land in 2018 simply because we cannot afford to pay for it.